Background

This case study is about a ficticious small business called Brum Cycles Limited, an electric scooters manaufacturing business based in The West Midlands Region of the United Kingdom.  The company is currently operating in a harsh economic enviroment whith high inflation, plus the exchange rate of the British pound against major cuurencies has been declining gradually for the past 24 months, and it expected to continue declining for the foreseable future. In addition to that Brum Cycles operates in a very competitive market in which technology is evolving at a very fast pace. This case study is based on events which ocurred during the company’s financail year which started on the 6^th of November 20X2 and ended on the 5^th of November 20X4. The business is owned and directed by Tina and Kaio, they are sibblings.

Note: When attempting the questions for this case study assume that you are employed by an accounting firm which provides business advice to Tina and Kaio.

Question 1

Task 1: Budgeting (45 marks)

Tina has been using static budgets for planning, controlling and decision making for the past few years. She read a business news article which suggested that fixed budgets on their own are an inadequate for benchmarking and decision making. According to Tina the article suggested flexible and flexed budgets are more effective. You have asked by your manager to use the data below to demonstrate how flexed budgets can be used by Brum Scooters Limited.

Last year the budgeted sales volume for scooters was 8,000 units but their actual sales volume was 11,500 units.

a) Complete the budget in the table above to show the forecast profit and the profit per unit for a sales volumes of 8,000 units and 11500 units. State the profit per unit to 2 decimal places. (4 marks)

b) Flex the budget to reflect the actual sales volume of 11,500 units and calculate the profit and the profit per unit. State the profit per unit to 2 decimal places. (7 marks)

c) Calculate the variances for last year’s budget and state whether they are favourable or adverse (14 marks)

d) Explain the causes of each of the variances for expenses and revenues in your flexed budget. (5 marks)

e) As mentioned above Brum Cycles is currently using a static budgeting regime. Your line manager believes that the business would make more effective decisions if it switches to a more realistic system of measuring variances. Yor line manager also argues that static budgets on their own are an in adequate for decision making. Write a short report for the directors of Brum Cycles in which you support the argument made by your manager. You must compare the pros and cons of static, flexed and flexible budgets in your report. You must also quote some of the variance fugures in your flexed budget. (15 marks)

 Question 1

Task 2: Cost-Volume-Profit (CVP) Analysis (30 Marks)

Tina and Kaio have limited knowledge of management accounting, they would like to know how their plans for next year may impact their profitability. Therefore, your manager has asked you to use the previous year’s master budget figures to complete a CVP analysis for next year.

a) Calculate the breakeven point in units and revenue. (2 marks) 

b) Calculate the profit volume ratio (2 marks)

c) Calculate the margin of safety in units for the sales volume of 11,500 units. (2 marks) 

d) Calculate the Margin of safety as a percentage for 11,500 units. State your answer to 2 decimal places. (2 marks)

e) Calculate the number of units that would need to be sold to make a profit of £98,800. Round your answer appropriately. (2 marks)

f) Your line manager had a meeting with Lulu and Tanaka and he recorded the notes below:

“Tina and Kaio have limited knowledge of accounting and finance, but they are aware of the following: “Breakeven analysis or cost-volume-profit (CVP) analysis is the study of the interrelationships between costs, volume and profit at various levels of activity. However, they are not aware of the fact that it has several limitations and assumptions until today.”

Your line manager would like you to write a report to Tina and Kaio in which you use your CVP analysis to address the following questions which they asked him: “ (1) How many scooters do we need to produce and sell in order to recover all of our costs for the next period?; (2) What is the amount of revenue we need to generate in order to recover all of our costs for the next period?; (3) How much will each scooter sold contribute towards covering our fixed costs and making a profit? (4) How much will each pound of sales revenue contributes towards our fixed costs and making a profit? ;(5) What is the extent to which our sales for the next period can decrease before a loss occurs?; (6) How units do we need to sell next year to make a profit of £98,800; and (7) Do the assumptions and limitations of your CVP analysis outweigh its benefits?.” (20 marks)

Question 2 (40 Marks)

Kaio specialises in managing the production function of the business, whilst Tina specialises in managing the administration plus the selling & distribution functions. Kaio has a degree in engineering. Tina has a diploma in bookkeeping and she is responsible for preparing and submitting statutory accounts. Tina has limited knowledge of management accounting, but she does some basic managements accounting tasks such as preparing static budgets and costing. As mentioned above the business is growing, and it is becoming more and more challenging for Tina to perform. all the administration tasks on her own. Therefore, Tina and Kaio have hired the firm of accountants you work for to support them with both financial accounting and management accounting tasks. You informed them that you will be stetting up a costing system which includes both marginal costing and absorption costing. Kaio does not understand why you need to carry out both marginal costing and absorptions costing. He believes that the company can save time, money and labour hours if they have one costing system. Your line manager would like you to demonstrate to Kaio why it may necessary for a business to adopt both costing systems. Therefore, he asks you to complete a report which includes statements of profit or loss under both costing systems for Kaio and Tina using the information below.

Midland cycles makes one product, with the following costs: variable direct materials £9 per unit, variable direct labour £6 per unit, fixed overheads £90,000 per year. During the last year the company made 7,500 units and sold 10,000 units for £25 each. There were 2,500 finished units in inventory at the start of the year. The costs for the previous year were the same as above, and have been used to value the opening inventory. 7,500 units were made last year.

a) Prepare the statements of profit or loss under absorption costing and marginal costing. (20 marks)

a) Use this information to prepare statements of profit or loss would using absorption costing and marginal costing. (20 marks)

b) It has already been stated above that Kaio does not understand why you have prepared two statements for the same product with different figures and different layouts. He thinks it is unnecessary to prepare two statements for the same product, and he also believes the company would save money and time if only one of the two statements were prepared. Your line manager would like you to write a report which will convince Tanaka that both statements are essential. Your line manager suggests that your report should compare and contrast the two profit and loss statements you prepared in terms of: (1) their objectives or purpose; (2) valuation of inventory; (3) the differences in cost of sales; (4) how costs are classified; (5) the differences or similarities in the profit or loss in the statements; (6) compliance or non-compliance with accounting standards; (7) Strengths; and (8) limitations. (20 Marks)

Qurestion 3 (65 marks)

Kaio and Tina are planning to invest in a new product. They require an annual rate of return of 10% from this projects and a payback period of 4 years. Tina has complied the data in the table below which she used to estimate the payback period for the project.

Tina thinks they should go ahead with the project because according to her estimation, they can recover their capital within their target period of 4 years. Your manager advised Tina and Kaio that payback period on its own is an inadequate decision making tool, and he aggreed with them that your firm would appraise the project using advanced techniques.

a) Your manager has delegated the task of appraising the project to you. Use the layout in the table below to show the workings for your calculations for payback period, net present value and discounted payback period. (30 marks)

b) What advise would you give to Tina based on the data in your analysis? (3 marks)

c) Your manager estimates that the internal rate of return for the project is close to 20%. Your managers asks to calculate the internal rate of using the NPV you calculated at 15%, and the NPV at 20% which is approximately £0.22. Show your workings. (5 marks)

d) What advise would you give to Tina and Kaio based on the internal rate of return you calculated. (2 marks)

e) Your manager would like you to presenst your capital investment appraisal computation and written reports at the next meeting with Tina and Kaio. He asks you to write a report to Tina and Kaio in which you elaborate on the advice he gave about using payback period on its own for appraising longterm projects, especially in the economic environment mentioned in this case study. Your report must compare the strengths and limitations of paypack period with the strengths and limitations of the discounted cashflow techniques you used in your analysis. (25 marks)

Important Information

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